Monday, September 17, 2012

Classic 1978 Milton Friedman Lecture on Trade

In the above 1978 lecture at Kansas State University, Milton Friedman
discusses free trade, and explains why trade protection and interference
in international trade are so widespread, despite the almost universal
condemnation of such measures by the economics profession.

Here’s a quote from
Friedman’s lecture, demonstrating the timeless nature of his economic
wisdom, which is as relevant today as it was in 1978:

In the international trade area, the language is almost always about how we must export, and what’s really good is an industry that produces exports. And if we buy from abroad and import, that’s bad. But surely that’s upside-down. What we send abroad we can’t eat, we can’t wear, we can’t use for our houses. The goods and services we send abroad, are goods and services not available to us. On the other hand, the goods and services we import, they provide us with TV sets we can watch, automobiles we can drive, with all sorts of nice things for us to use. The gain from foreign trade is what we import. What we export is the cost of getting those imports. And the proper objective for a nation as Adam Smith put it, is to arrange things, so we get as large a volume of imports as possible, for as small a volume of exports as possible.

This carries over to the terminology we use. When people talk about a favorable balance of trade, what is that term taken to mean? It’s taken to mean that we export more than we import. But from the point of view of our well-being, that’s an unfavorable balance. That means we’re sending out more goods and getting fewer in. Each of you in your private household would know better than that. You don’t regard it as a favorable balance when you have to send out more goods to get less coming in. It’s favorable when you can get more by sending out less.

MP: Here’s a formula summarizing Milton Friedman’s insights:

1. The stuff we import

MINUS2. The stuff we export =

3. Our standard of living

In other words, in economic terms, our standard of living is highest
when we maximize imports and minimize exports, which is exactly the
opposite of the political thinking and policies, which generally seek to
maximize exports and minimize imports.

77 Comments:

Counter-intuitive but true. I check our longest period of expansion and discovered this to be true. During the 90's our level of imports were 3 and 4 times as much as our exports. But is this to say we should run large trade deficits?

Only counter-intuitive because the political dialogue has conditioned us to believe that trade deficits are not good. Logically, Milton is correct.

We should not try to "run" trade balances to either deficit or surplus, just let them be what they will without government interference. Milton's point was that a trade deficit is a sign that our standard of living is increasing.

Many of our trading partners exchange their goods for U.S. dollars, instead of U.S. goods, and invest those dollars in U.S. Treasury bonds.

So, there's more money available for U.S. education and less money is needed from the U.S. private sector.

Consequently, the U.S. not only leads the world, it leads the rest of the world combined in the Information and Biotech Revolutions (in both revenues and profits), in part, because of more spending on education and more investment in emerging industries.

Also, I may add, in raising U.S. living and labor standards, an increase in the minimum wage of $0.50 costs less than $2 billion, which is very little compared to the up to $800 billion a year U.S. trade deficits in the mid-2000s.

Consequently, the U.S. not only leads the world, it leads the rest of the world combined in the Information and Biotech Revolutions (in both revenues and profits), in part, because of more spending on education and more investment in emerging industries.

Your spending on education is not very wise. American kids do very poorly compared to the rest of the world and most of the research is done by foreigners who come to the US for better opportunities. The US does better because it has had a better system, not because there is anything particularly special about Americans. The trouble is that the system that gave Americans such a great advantage has slowly been eroded by the growth of government. And the rest of the world is catching up.

Also, I may add, in raising U.S. living and labor standards, an increase in the minimum wage of $0.50 costs less than $2 billion, which is very little compared to the up to $800 billion a year U.S. trade deficits in the mid-2000s.

The minimum wage is responsible for the loss of many jobs as it prices the unskilled out of the market. Skilled workers do not need minimum wage laws because they make more than the minimum wage. Reading an economic textbook might be useful. This is one subject where there is widespread agreement among serious economists.

Don't economists also favor a VAT and lower capital gains tax rates to reduce consumption and promote savings. Doesn't this run contrary to what Friedman is saying. I think at a macro level a country that has a trade deficit probably has a low savings rate, which has been true for the US. Are there examples to the contrary. I think the US is a special case that due to the dollar being the reserve currency it hasn't suffered from lack of investment despite a very low savings rate.

Don't economists also favor a VAT and lower capital gains tax rates to reduce consumption and promote savings. Doesn't this run contrary to what Friedman is saying. I think at a macro level a country that has a trade deficit probably has a low savings rate, which has been true for the US. Are there examples to the contrary. I think the US is a special case that due to the dollar being the reserve currency it hasn't suffered from lack of investment despite a very low savings rate.

you can import all the time and never export at all quite sustainably.

the economy at home keeps growing. we turn some into money, and spend it abroad for goods.

that does not require us to export goods. we can, but we do not need to.

they can stuff the money in a mattress, use it to buy us goods, or use it to invest in the us. (stocks, treasuries, businesses, etc).

thinking of only the trade account is too limited. if you buy a japanese car for $30k and the japanese company spends that $30k to help build a dealership here, that's the capital account offsetting trade. you have a balance overall, but it looks like a "trade deficit".

in many ways, such a pattern is the best thing that can happen to us standards of living. we get a car we want and that money we paid for it gets invested in the us to make it easier to buy more.

"Some economists favor a VAT because it is an economically efficient tax. The goal is never to reduce consumption. "

where people get confused here is that there is a basic notion: if you tax something, you get less of it.

currently we tax income and we also tax investment, often doubly.

the current tax code deeply favors consumption and debt accumulation and is stacked against investment which is nearly always double taxed. (you pay on income then pay again on the investment or a company pays on income then you pay again on dividends etc)

a VAT would favor investment over consumption. many take this to mean it would reduce consumption. this might be so in the very short run, but in the medium and long term, the increased incentives to invest would greatly increase growth and wealth accumulation which is what will ultimately drive consumption. it might make consumption smaller as a % of the pie, but the pie would likely grow so much faster than consumption would go up nominally, likely more so than under and income tax.

Imagine a country who imports raw materials, refines them, then exports the finished products. The exports would be higher than the imports (on a value basis), and thus the GDP would be higher than it would be in an autarky scenario.

Also, there are hundreds of major economic forces pushing and pulling a large economy, not one or two that you may find in a textbook.

This is a very good point Peak made. It is easy to slip into the "one man to blame" type of thinking: it's the bankers' fault, it's Wall Street's fault, it's the government's fault. I fall into that trap from time to time. But, quite frankly, it's the lazy man's analysis. Nothing is ever the cause of just one thing. Sure, the government plays a role, but to blame them exclusively is wrong. Sure, the bankers play a role, but to blame them exclusively is wrong.

No. Friedman may have been a statist but would not have been happy with the extent of the interference in the economy and the intrusive regulatory regime that is facing workers, consumers, and producers. The US has not ever had a free market.

I think at a macro level a country that has a trade deficit probably has a low savings rate, which has been true for the US. Are there examples to the contrary. I think the US is a special case that due to the dollar being the reserve currency it hasn't suffered from lack of investment despite a very low savings rate.

Having a reserve currency has helped. But losing that status presents a massive danger to the American economy. Which is why I would not be complacent about zero interest rates as far as the eye can see.

The idea of a VAT is not to be an additional tax, but a replacement one. In theory, it would replace the income tax and profit tax.

Things don't work this way. Usually when one tax is added the old one is never reduced by as much as the supporters of the new tax promised. But none of this is very important because the US does not have a taxation problem. It has a spending problem.

Last time I looked, most of the workers in the U.S. are American and U.S. per capita income is much higher than other large countries.

Education is not the reason. An interesting study looked at the Swedish myth and found that Swedes who had moved to the US had much higher incomes than those that stayed in Sweden even when accounting for educational levels and other factors.

Confusing correlation with causation is not exactly a valid support for a thesis.

"Reading an economic textbook" is not enough to even begin to understand economics.

I agree totally. That is the problem with American economic education. It has its students read crap written by people like Samuelson and Nordhaus and confuses them by teaching Keynesianism and neo-Keynesian monetarist theory. Because both are statist schools favouring central planners its advocates are found in academia and government agencies and get appointed to high advocacy positions. The problem is that most know nothing of the real economy and are responsible for making all kinds of idiotic policies that push the real economy closer to the abyss even though historical events show that Eastern Europe, Asia, and the EU have taken the same statist path and failed.

This is a very good point Peak made. It is easy to slip into the "one man to blame" type of thinking: it's the bankers' fault, it's Wall Street's fault, it's the government's fault. I fall into that trap from time to time. But, quite frankly, it's the lazy man's analysis. Nothing is ever the cause of just one thing. Sure, the government plays a role, but to blame them exclusively is wrong. Sure, the bankers play a role, but to blame them exclusively is wrong.

The glue that holds everything together is the money used in society. When bankers have a monopoly on its creation and are given the power to counterfeit you can blame them for many of the problems that face us.

It is likely that people who have the intelligence, persistence, and focus that is required to get a degree can sue that intelligence, persistence, and focus to earn a higher income than people who don't measure up.

Money has nothing to do with economics? Try telling that to all those people who saw their savings wiped out by printing presses or anyone who expects QE to have an effect on the economy.

You are confusing money with savings. Not the same thing.

Money has nothing to do with economics. Economics is the study of the allocation of scarce resources. How do we distribute our resources (land, labor, capital, entrepreneurial ability)to maximize their value? None of this has anything to do with money.

Money is a medium of exchange. It facilitates trade, but individuals do not pay for things with money, per se. Individuals pay for things by trading their goods/services for other goods/services. I trade my economic analysis ability for food, clothing, rent, entertainment, etc. Money just makes that trade easier. Rather than going to the grocery store and saying "I will analyze the economy for a bunch of grapes", I do that for my employer, and he gives me cash, which I then use to buy my grapes. Money is an equalizer, that is all.

Most people do not save in money. Most people will invest in the hopes that the return will yield greater.

I will concede that, as folks get older, they move into saving in money, as that is less risky than other investments. However, even then, inflation's effects are relatively muted, barring a massive inflationary period.

The point is, people do not trade in money. They trade in resources. They trade production for consumption. Money merely facilitates that exchange. Economies thrive everywhere without money.

I would argue that you are confusing a fiat currency with free market money.

Money has nothing to do with economics. Economics is the study of the allocation of scarce resources. How do we distribute our resources (land, labor, capital, entrepreneurial ability)to maximize their value? None of this has anything to do with money.

When the central banks create money and credit out of thin air they send the wrong signals to the people who allocate scarce resources. The artificial interest rates confuse investors and they make decisions that are not wise. That is how we got the tech and housing bubbles and why all of those large construction projects tend to have massive cost overruns.

No disagreement here. But fiat currencies are not the market's choice of a medium of exchange. Eliminate the legal tender laws and you will see just how little value the paper money really has. I believe you suffer from the 'America is different' myth. In my time I have seen a number of fiat currencies rapidly devalued or/and destroyed. That is because they were not the market's choice of money but a government imposed monopoly.

Here's the thing: inflation is a monetary and temporary phenomena. Periods of hyper-inflation tend to be very short-lived, because the economy adjusts. Ultimately, the economy always adjusts back to its proper level of activity. Regardless of what the "price" of things are, it is the costs that matter. Fiat currency does not take that into account.

Inflation, money printing, they are all red herrings used to distract from underlying problems.

The typical instances of hyperinflation in history (Germany in 1920's, US in 1970's, Zimbabwae earlier this decade) are often blamed on the government running the printing press, but that is a symptom, not the cause of the problem. It's a convienant excuse, but ignores all the other more important factors.

Look, money doesn;t mean anything. This is why I get so upset with this asinine discussions about inflation and the CPI. They measure shit. They tell us very little about the state of the economy, and yet they are constantly hyped.

You have the "sky is falling" inflation-types. You have the "Japan" deflation-types. You're both wrong. Inflation, deflation, doesn't matter a whole lot. They are temporary. You have your ups and your downs, but, as always, people adjust and return to their natural levels of growth. To say the government has the power to destroy an economy by running a printing press is to give them way too much power.

Let's get realistic here. On the one side, we have false pharisees who claim the government can solve all our problems. On the other, we have pharisees who claim the government is the source of all our problems. To both of you I say: the government does not have the kind of power you imagine they do. This cult of government needs to stop now, because both of you are eroding our rights, some though legislation and some by preemptively surrendering them. All of us need to stand up and take responsibility for our own actions. We do not live or die by the whims of government; we live or die by our own whims.

If you want to figure out who is to blame for the past recession, there is plenty of blame to go around: bad government policies, greedy bankers, greedy borrowers. To blame everything on one party is simplistic. You'd only be accounting for about 1% of the blame. If you really want to play the blame game, then let's be fair about it. Everyone deserves their fair share.

The government deserves some blame, so let's blame them. Wall Street deserves some blame, so let's blame them. The banks deserve some blame, but let's blame them. Borrowers deserve same blame, so let's blame them. But let's not be afraid to look in the mirror and blame ourselves here, too. No one here is free of sin. The only way we can redeem ourselves and get this economic recovery back on the fast path is to fix ourselves. But as long as we keep hurling these balls of blame around, we will get nowhere. Until we stop saying "It was all the (bankers, Wall Street, government, GOP, Dems) fault, then we will go nowhere.

The economy (and the planet, for that matter) is made up of individuals. That means we need to take individual responsibility rather than pulling a Pilate and saying "my hands are clean."

Your ideas are not heretical, there is logic and alot of reasoning behind them, even though I do not agree with some of it, I concurr with the general theme.

Wall St., Bankers, Government, Main St., these are not people, they cannot be "blamed" for the crisis. Mainly, they are abstract groups of people who work in the same area/industry. They are not "responsible".

We all are responsible, every single citizen in the country is for this is what we as a people have allowed to happen to our system.

Where I differ from your thinking is that while I agree mistakes were made by many in wall street and on main street and by home owners and lenders, these mistakes on their own would not have caused the huge financial damage that occurred in our country, nor would they have caused the long and painfully slow recovery, had it not been for the misguided meddling of the government in the economy and in the respective markets where the most damage was done.

Individual humans make mistakes, that is part of being human. However, the unintended consequences of the myriad and massive interference of government policies amplified the effects of those human mistakes so that we had massive reactions in the economy, much larger than would be the case in a dynamic free market capitalistic system with limited government interference.

That is the fault of government. But the blame lies with all of us for letting it get to that point.

To solve it, we need to turn the tide so the in the coming years/decades when the choice is for more or less government interference, we choose less. So that we can get the country back to the days when it was the land of opportunity for anyone who wanted to work hard to make something of themselves.

Here's the thing: inflation is a monetary and temporary phenomena. Periods of hyper-inflation tend to be very short-lived, because the economy adjusts. Ultimately, the economy always adjusts back to its proper level of activity. Regardless of what the "price" of things are, it is the costs that matter. Fiat currency does not take that into account.

No. They are brief because the fiat money dies.

And you are damn right that costs matter. The trouble with your view is that the Fed manipulates the cost of money by gaming the yield curve not only on the short end of the curve but all along that curve.

Inflation, money printing, they are all red herrings used to distract from underlying problems.

No, central planning does not work. Period. And that is what you have when the central bank has a monopoly on the creation of money and is able to create money and credit out of thin air. The housing bubble did not blow itself. It was created by a Fed trying to deal with a popped tech bubble by injecting liquidity into the system.

The typical instances of hyperinflation in history (Germany in 1920's, US in 1970's, Zimbabwae earlier this decade) are often blamed on the government running the printing press, but that is a symptom, not the cause of the problem. It's a convienant excuse, but ignores all the other more important factors.

They could not have happened in a hard money system that restrained government. Period.

Look, money doesn;t mean anything. This is why I get so upset with this asinine discussions about inflation and the CPI. They measure shit. They tell us very little about the state of the economy, and yet they are constantly hyped.

Of course it matters. When the central banks create money and credit and meddle with natural interest rates they send false signals that allow a misallocation of scarce resources. And that is why we have massive bubbles that burst and create economic turmoil. If you were prudent and saved your money shouldn't you benefit by being able to buy assets and consumer items cheaply? Why does it not matter when the Fed devalues your purchasing power by printing and exploding its balance sheet?

You have the "sky is falling" inflation-types. You have the "Japan" deflation-types. You're both wrong. Inflation, deflation, doesn't matter a whole lot. They are temporary. You have your ups and your downs, but, as always, people adjust and return to their natural levels of growth. To say the government has the power to destroy an economy by running a printing press is to give them way too much power.

The damage done is not temporary for people who do not have time to repair their balance sheets.

Let's get realistic here. On the one side, we have false pharisees who claim the government can solve all our problems. On the other, we have pharisees who claim the government is the source of all our problems. To both of you I say: the government does not have the kind of power you imagine they do. This cult of government needs to stop now, because both of you are eroding our rights, some though legislation and some by preemptively surrendering them. All of us need to stand up and take responsibility for our own actions. We do not live or die by the whims of government; we live or die by our own whims.

Government has the power to rob you through confiscation. It has the power to make you poorer by waging war or by passing legislation that limits your economic opportunities. It has the power to limit your economic and social freedom. So excuse me if I am not as dismissive of the problem as you are.

If you want to figure out who is to blame for the past recession, there is plenty of blame to go around: bad government policies, greedy bankers, greedy borrowers. To blame everything on one party is simplistic. You'd only be accounting for about 1% of the blame. If you really want to play the blame game, then let's be fair about it. Everyone deserves their fair share.

Who created the housing bubble? Who got the country into two wars that have cost trillions? Who tried to kill the coal industry? Who stopped drilling for oil in the Gulf? Who added 50% more to the national debt in the last 4 years? Who stole SS and Medicare contributions and replaced them with IOUs?

Agreed. But why bail out Wall Street firms that created much of the problem?

The banks deserve some blame, but let's blame them.

Same as above. Let the banks who made errors fail and their investors lose their equity.

Borrowers deserve same blame, so let's blame them.

Yes. They should be left to go bankrupt. Let us stop trying to save them by having the Fed buy mortgage paper in an effort to blow up another video.

But let's not be afraid to look in the mirror and blame ourselves here, too.

Why. I never voted for the politicians or supported any bailout. I never jumped on the housing bandwagon or asked for the Fed to increase liquidity.

No one here is free of sin.

When logic fails let us by all means go to faith. What does your 'sin' have to do with the economy?

The only way we can redeem ourselves and get this economic recovery back on the fast path is to fix ourselves.

Wrong. The economy was ruined by high taxes, money printing, and loose lending standards. More of the same will not repair the damage without kicking the can down the road and creating a bigger problem. Instead of having them deal with the consequences you want to liquor up the sinners and let them continue partying.

But as long as we keep hurling these balls of blame around, we will get nowhere. Until we stop saying "It was all the (bankers, Wall Street, government, GOP, Dems) fault, then we will go nowhere.

Until you recognize that it was the monetary policies and wars then you won't get anywhere.

The economy (and the planet, for that matter) is made up of individuals. That means we need to take individual responsibility rather than pulling a Pilate and saying "my hands are clean."

By all means have individuals deal with the consequences of their action. But why are you calling for collective action that bails out the individual sinners?

Your ideas are not heretical, there is logic and alot of reasoning behind them...

When I said that, I was referring to my ideas about money. There is probably not a single established economist on either side of the debate who would agree with me. But that doesn't mean anything. I just need to flush out my ideas more. Still quite raw at this point.

Givemefreedom, I think we are saying the same things, just in different words. You may not disagree with me as much as you think :-)

Correct me if I am wrong, but I am reading your general comments as saying government amplified the complications that arose?

I agree with this point (if that is indeed your intended point. Please correct me if I am wrong). This is why I don;t like to point the accusing finger at Washington and say "HERE IS THE PROBLEM!!!!!!!"

The way I see government in the economy is as an amplifier. If you go to a concert, you hear music from the amps. It wouldn't be right to say the amps are causing the music, would it? The amps magnify it. That is what government does. It magnifies problems and spreads them out. What would have been contained to one small area is now projected across the entire venue. You can blame the amp for that.

We all are responsible, every single citizen in the country is for this is what we as a people have allowed to happen to our system.

Really? Did you decide to blow up a housing bubble by injecting liquidity into the economy and finance two foreign wars without resorting to taxation? Did you decide to buy up $40 billion in mortgage paper every month from now until eternity? Did you push the banks to lend to low income people without credit? Did you rate junk paper AAA? Did you lie on your application so that you could buy a home that you could not afford?

I know that I didn't. And I know that this collective guilt crap makes me feel somewhat nauseated. My preference is for taking responsibility for my own actions not for those of others.

The only quibble I would have is your claim that government doesn't have much power. Government has a monopoly on the use of force, and is the tool used by groups of individuals to enforce their interests over the interests of others. a good example would be Regulations designed to favor a business over its competition.

While we would expect any group to promote its own interests for the benefit of it's members, we wouldn't expect those we elect to represent out interests, to act against our interests as consumers and taxpayers.

Therefore, IMHO, government shares a greater portion of any "blame" to be handed out than others who are only acting in their own interest.

While it's true that we elect those who so often seem to betray our trust, it's not clear that the choices we have are really our choices.

Without the force of government all those other actors you mentioned would be at the mercy of market forces, the risks would be their own, and their success would depend on their ability to please consumers.

The solution would seem to be less government power, although a reduction may not even be possible at this point.

I consider the Fed a part of government for the purpose of this blame allocation. :)

"The way I see government in the economy is as an amplifier. If you go to a concert, you hear music from the amps. It wouldn't be right to say the amps are causing the music, would it? The amps magnify it. That is what government does. It magnifies problems and spreads them out. What would have been contained to one small area is now projected across the entire venue. You can blame the amp for that."

Yes, that's a good analogy. I blame the amps for my hearing loss, not the musicians. :)

Without those amps, however, physics (market forces) would have protected my hearing no matter how hard those evil musicians tried to hurt me for their own gain.

The solution then, is to reduce the value of amps to musicians by reducing their power. We like to think we can vote for such changes, but the amps may have overcome that limitation.

The only quibble I would have is your claim that government doesn't have much power.

Let me expand on this point.

It is true that government has a monopoly on the use of force. However, that is a very poor tool for control.

In every action the government undertakes to control, a black market emerges. Drugs, alcohol, abortion, kidneys, baseball cards, gasoline, music, tv, whatever. Despite a government's best efforts, it cannot squelch these things. That is what I mean when I say they are powerless. Despite years of trying and billions of dollars, drugs still exist. Despite their best efforts to propagate certain viewpoints, cigarettes still exist.

Government likes to puff out its chest and throw sticks around, but it simply can't kill the ants.

If you point to a government that has complete control over an economy, I will show you the elaborate black market underneath: Nazi Germany, the Soviet Union, the Roman Empire, Communist China. They all had them.

I am about to get metaphysical here. If that offends you, skip to the next paragraph. Government only has the power that you give it. That is why they work so hard at thought control. If you are duped into believing government is this all-powerful entity, then you are already in its power, regardless of your personal feelings. Liberty is more than just a freedom from meddling government. Liberty is an idea. It resides deep in the soul of every human being and most animals (insects with hive-minds confuse me). If I were arrested today and shot tomorrow, I would still live on because the ideas of liberty will live on. My ideas will persist, just as they have for centuries before me and centuries after. And the best part? There is not a damn thing the government can do about it. Ideas are immortal.

Look at all the times governments have tried to eradicate a culture. How many of them have worked? Are the Greeks gone? The Aztecs or Mayans? The Christians or Jews or Muslims? The Chinese? the Japanese? The Native Americans?

The best thing we can do as individuals is to not give in. Not submit. Not buy into their fantasy. Once you have done that, you are already indoctrinated.

"I am about to get metaphysical here. If that offends you, skip to the next paragraph. Government only has the power that you give it."

Not offended in the least. That's a great paragraph, and you are absolutely correct.

I would say in far fewer words, but much less eloquently that we each have inalienable rights.

You are also correct about black markets. Government has no absolute power over us, but seems, for the most part, to work at cross purposes to our best interests, causing much needless pain and aggravation.

The less government the better IMHO.

The notion that government must have a monopoly on so-called public goods seems baseless.

Jon said,Liberty is more than just a freedom from meddling government. Liberty is an idea. It resides deep in the soul of every human

Right on Jon, that has defined human history from the moment we stood upright, our neverending fight for freedom. The founding fathers understood that and tried to safeguard us from an overeaching government with the constitution. We have slow drifted away from that over the last 200 years.

Liberty is an idea, but you have to fight to get it and stay vigilant so that it does not get taken away from you.